Child trust funds (CTFs) will be scrapped as part of the government's spending cuts, chancellor George Osborne and chief secretary to the Treasury David Laws announced today.

From August CTF payments will be reduced from £250 to £50, with children from lower income households receiving £100, down from £500. Children will no longer receive an additional payment when they are seven and from January next year the payments will be abandoned altogether.

The flagship children's savings scheme was launched by Labour in 2002 and currently provides new parents with a £250 voucher which they can invest, tax-free, for 18 years in a shares or cash-based account. A further £250 is provided when the child turns seven, but in the meantime parents, grandparents or others can top up the account up to an additional £1,200 a year.

The government had said in its provisional coalition statement earlier this month that the Conservatives and the Liberal Democrats had agreed that reductions could be made to the CTF, and it was widely anticipated that this would mean scrapping it altogether. This was confirmed today.

Laws said that scaling back and then scrapping CTFs would save £320m over the next tax year, and that £20m of this will be spent on extra "respite breaks" for disabled children. He said that payments to disabled children due this year will be made.

Over the weekend, campaigners launched a last-ditch battle to try to save CTFs, arguing that scrapping them would only benefit the well off. The group was made up of an unlikely alliance of left-leaning thinktanks and academics, plus City fund management groups.

Kate Moore, head of savings and investments at Family Investments, said: "The CTF scheme has helped to create a generation with a head start in life, and social mobility is likely to suffer if young people are unable to meet the costs of higher education or find the money required for a deposit on a first property."

Andrew Hagger from Moneynet.co.uksaid that by saving just £22.50 a month on top of the two £250 payments from the state, a CTF with growth at a modest 4% would be worth £7,964.70 by the time a child reached 18 years of age.

"If the CTF scheme had been allowed to continue, come September 2020 when the first accounts would have matured, there would have been a stream of 18-year-olds entering adult life on a much sounder financial footing than previous generations – does it really make economic sense to have wiped that out in one fell swoop?" he said.

But Laws said the Treasury would be "deceiving" people if they were handed funds that were from borrowed money.